About a month ago I was lectured by some pitch playing buddies in the 19th hole at the country club. They must have been waiting for me because I walked over to their table and without uttering a sound the abuse kicked in. Friend #1 asked me what the market was going to do next month (it was 10/01/21 and he probably read an expert’s market letter that afternoon). My reply was short and sweet…”Don’t know…probably go up.” Friend #2 basically interrupted by adding “It’s way overdue for a correction!” #1 agreed, “no way this thing doesn’t crater!” #2 was resolute “it has to go down; no way stocks can maintain these prices.”
I frequently find myself being drug into conversations like this. I rarely retort, defend, or even contribute. I learned long ago that most people are hardwired for disaster; psychologists refer to this as the “negative bias” and it can have a powerful effect on a person’s behavior. When confronted, these same two card-playing buddies would probably argue that they don’t actually hold this bias and instead would characterize themselves as being quite positive (denial).
Most psychologists (feel free to Google) hold the opinion that negative emotions require more thinking to maintain and as a result, often occupy front of mind positions. Add the concept that brickbats are recalled more quickly than praise and the future quickly become colored by negative thoughts… bad is stronger than good. My pitch playing buddies are still my friends and I value them. However, the S&P was up 6.9% in October. I doubt that went unnoticed, but neither one of them mentioned it. That rate of return equates to 82.80% annually. I don’t look for anything near an 83% return over the next 12 months, but I don’t expect my pals to broach this subject again quickly. There will be fewer complaints over the near term because new erasers wipe clean. Remember that concept, “new erasers wipe clean.”
Observant readers of our quarterly letters will tell you that technical analysis plays a limited role in our thinking. We are bottom’s up stock pickers. However, from time to time the technical guys hold sway, as do the top-down economists, and of course, the ever-popular value guys. Top-down pundits and value guys are pretty easy for most to understand, but the technical guys aren’t.
I will attempt to explain one small slice of technical analysis. I call it quantifying buyers and sellers. As prices decline, portfolios hold “dead wood” which “wants” to be sold. As markets make new highs (today), there are fewer mistakes that need to be resolved because literally all positions represent a gain. As a result, there are very few investors that want to eliminate unsuccessful positions by selling. These new highs are the erasers that wipe clean. The markets we are talking about are not just making new highs, but ALL-TIME highs.
Let’s belabor the point a little bit and “quantify” the buyers and sellers. At the beginning of each month there is a pre-determined number of buyers that will function through thick and thin. They are dollar-cost averaging types, retirement plan contribution trades, systematic investors of cash…the kinds of trades that we know will happen month-in and month-out. Most of these trades are executed religiously and by computer. There is a duplication of these trades on the 15th of the month and again at the end of the month. When markets are hovering at all-time highs, there is a dearth of natural sellers and these trades tend to drive prices higher. During these times investors tend to be happy with their positions (remember, virtually all profits) and only interrupt when they think they are buying a better value than they are selling. They are not confronted with getting out from under a bad stock or needing to sell just to clean up their books. They are holding profitable positions and are inclined to stand pat. What we are describing is a very tight market, with little position-squaring going on and generally driven higher by preordained trades confronting a group of generally disinterested sellers.
The markets have been making new highs since I was issued my first yellow pad and pencil. They do this in a see-saw manner and today’s scenario is unique. In order to establish all-time lows, they need to revisit prices seen at the turn of the century, that’s 1899 not 1999. They do correct from time to time because of wars, natural disasters, political upheavals, pandemics, and speculation. These events commonly create corrections which then produce recent, annual, and seasonal highs and lows. All in all, it really is a pretty stable price environment and one of the reasons we like to say, “stocks can do anything bonds can do better.” You could also think of the current scenario as the highest prices ever recorded in the history of man (perhaps woman). The reason, you guessed it, a new eraser wipes clean. This is a very unique environment and could easily take a long time to unravel. We still really like equities.
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